Feb. 12 (Bloomberg) -- Bank of New York Mellon Corp. was
prohibited by the U.S. Tax Court from claiming $199 million of
foreign tax credits generated in a transaction arranged by
Barclays Bank Plc and KPMG LLP.

The tax court said BNY Mellon couldn’t claim the tax
credits and related expense deductions for 2001 and 2002 because
the underlying transaction with London-based Barclays “lacked
economic substance.”

“U.S. tax laws and treaties do not recognize sham
transactions or transactions that have no economic substance as
valid for tax purposes,” Judge Diane Kroupa said in yesterday’s
ruling.

BNY Mellon said yesterday in an e-mailed statement that it
would take an after-tax charge of about $850 million during the
first quarter because of the ruling. While the ruling directly
affects only two years, the amount of the charge reflects about
six years of tax benefits connected to the disputed transaction,
according to the company’s 2011 annual report.

“We will appeal the court’s decision,” Kevin Heine, a
spokesman for New York-based BNY Mellon, said in a phone
interview. “We continue to believe the tax treatment of the
transaction was consistent with statutory and judicial authority
existing at the time.”

Kroupa’s decision upholds a ruling by the U.S. Internal
Revenue Service disallowing tax benefits resulting from an
elaborate set of financial exchanges known as a Structured Trust
Advantaged Repackaged Securities, or STARS, transaction.

‘Circular Flows’

The 2001 transaction purported to give BNY Mellon below
market rate financing from Barclays and involved the transfer of
income producing assets from the U.S. bank to a trust with a
U.K. trustee and subject to U.K. income tax, according to
Kroupa’s ruling.

“The STARS transaction was a complicated scheme centered
around arbitraging domestic and foreign tax law
inconsistencies,” Kroupa wrote. “The U.K. taxes at issue did
not arise from any substantive foreign activity. Indeed, they
were produced through pre-arranged circular flows from assets
held, controlled and managed with the United States. We conclude
that Congress did not intend to provide foreign tax credits for
transactions such as STARS.”

Barclays, KPMG

Barclays and KPMG developed and promoted STARS to U.S.
banks, according to the ruling.

Kerrie Cohen, a spokeswoman for Barclays, declined to
comment on the ruling.

Manuel Goncalves, a KPMG spokesman, declined to comment on
the decision, citing a confidentiality obligation to its client,
BNY Mellon. KPMG LLP is a U.S. affiliate of Zurich-based KPMG
International.

The IRS is challenging a total of $900 million of tax
benefits, including interest, over six years connected to
payment of U.K. corporate income tax credited against BNY
Mellon’s U.S. tax liability, according to BNY Mellon’s 2011
annual report.

Kroupa’s ruling applied only to two years worth of disputed
benefits.

The liability was incurred by The Bank of New York Co. and
was carried into its merger with Mellon Financial Corp. in 2007.

The case is Bank of New York Mellon Corp. v. IRS, 09-26683,
U.S. Tax Court (Washington).